Three years ago, a mid-sized company signed a financing agreement with a syndicate of banks. The agreement requires a net debt to EBITDA ratio below a threshold, tested at each half-year close, and a compliance certificate to be submitted within four months. Two amendments have changed the definition of EBITDA that applies. An acquisition added a second agreement, with its own ratios and its own definitions.
Nobody rereads these documents between two closes. By the time the ratio nears the threshold, the finance department finds out at the same time as its lenders.
What the agreements contain
A corporate financing agreement brings together several families of commitments:
- financial ratios: leverage, interest cover, minimum equity, capital expenditure cap;
- information undertakings: accounts to be provided, certificates of compliance with the ratios, delivery deadlines;
- positive and negative undertakings: limits on additional borrowing, asset disposals and dividend distributions;
- change-of-control clauses and events of default.
Each ratio has its own contractual definition, often different from the usual accounting aggregates: an EBITDA adjusted for certain items, a net debt that may or may not include leases. This definition prevails, and it can change with each amendment.
What the system does
The system reads the financing agreements and their amendments in their signed version. It:
- extracts each commitment, its definition, its threshold, its test date and the accompanying information obligation;
- applies the latest version of each definition, amendments included;
- recalculates the ratios at each reporting date, using the entity’s actual accounts;
- projects their trajectory over the next test dates, based on the budget or the cash flow forecast;
- flags ratios that are nearing a threshold, and upcoming reporting deadlines.
Control: every figure points back to its clause
A second system, separate from the one that did the calculation, checks each ratio before it reaches the finance department:
- each ratio points to the clause that defines it, in the version of the agreement currently in force;
- each component of the calculation points to the accounting lines that feed it;
- an ambiguous contractual definition is flagged for a decision, rather than resolved silently;
- two agreements that define the same aggregate differently are shown side by side.
The CFO can then show lenders, or the statutory auditor, how each ratio was arrived at.
What remains the finance department’s responsibility
The system calculates and raises alerts. The decisions that follow rest with the department: renegotiating a threshold, requesting a waiver, adjusting an investment, preparing for a discussion with the banks. The legal interpretation of a disputed clause is a matter for its advisers.
Where to start
You will need:
- the financing agreements and their amendments, in their signed version;
- the accounts for the last financial years and the most recent reporting dates;
- the budget or cash flow forecast, for the projection;
- someone from the finance department, to validate the first extractions.
The system works on these documents, without connecting to the accounting system. Results are measured by the time between a ratio starting to drift and the finance department seeing it, and by the time spent preparing certificates.
Other uses of AI in finance, and a detailed scenario, are described on the page AI for finance departments, asset management firms and advisory firms.